A Krona Problem

There is a New York Times story about what is going on in Iceland – and one thing jarred me – the quoted exchange rate.  They quoted 130 to the dollar which suggests the Krona has only lost half its value. 

This seems a little mild compared given what has happened to the country – it has effectively defaulted on international deposit insurance obligations and had the IMF step in.

But the Central Bank of Iceland gives an exchange rate – and the exchange rate matches the New York Times story.  The NYT however says that the banks are rationing foreign currency – which suggests that the published exchange rate is a nonsense.  Still the IMF money can be supporting an exchange rate - I really do not know.  

Anyway here is the sequence of Krona per Euro exchange rates as published by Sedlibank. 

9/15/2008	129.64	130.36	130.0
9/16/2008	130.15	130.87	130.51
9/17/2008	131.13	131.87	131.5
9/18/2008	135.32	136.08	135.7
9/19/2008	131.29	132.03	131.66
9/22/2008	130.05	130.77	130.41
9/23/2008	138.03	138.81	138.42
9/24/2008	139.32	140.1	139.71
9/25/2008	135.8	136.56	136.18
9/26/2008	140.72	141.5	141.11
9/29/2008	142.45	143.25	142.85
9/30/2008	145.08	145.9	145.49
10/01/2008	152.62	153.48	153.05
10/02/2008	154.39	155.25	154.82
10/03/2008	155.65	156.53	156.09
10/06/2008	154.91	155.77	155.34
10/07/2008	135.83	136.59	136.21
10/08/2008	172.16	173.12	172.64
10/09/2008	143.87	144.67	144.27
10/10/2008	149.74	150.58	150.16
10/13/2008	149.79	150.63	150.21
10/14/2008	149.96	150.8	150.38
10/15/2008	149.58	150.42	150.0
10/16/2008	150.08	150.92	150.5
10/17/2008	150.58	151.42	151.0
10/20/2008	150.08	150.92	150.5
10/21/2008	150.08	150.92	150.5
10/22/2008	150.08	150.92	150.5
10/23/2008	150.58	151.42	151.0
10/24/2008	151.58	152.42	152.0
10/27/2008	151.58	152.42	152.0
10/28/2008	152.07	152.93	152.5
10/29/2008	152.07	152.93	152.5
10/30/2008	152.57	153.43	153.0
10/31/2008	153.07	153.93	153.5
11/03/2008	159.55	160.45	160.0
11/04/2008	163.54	164.46	164.0
11/05/2008	163.54	164.46	164.0
11/06/2008	165.54	166.46	166.0
11/07/2008	165.54	166.46	166.0

I have highlighted the day of full collapse.  There is a Bloomberg article from the crisis day which quotes the Krona trading at 350 to the Euro – way worse than the official exchange rate. 

In most developing countries a black market develops pretty quickly in foreign currency when this sort of thing happens.  Often the street rates are way different from official rates.  [You want a big difference – go to Burma…]

Are the Icelandic people so law abiding they have not developed a street market or is the official rate real? 

What is meant by banks rationing foreign currency?  The New York Times doesn't give an answer.  Can someone with real experience in trading in Iceland post crisis (or someone from Iceland give me an answer).  I am surprised at the data.

If the Krona finds a freely convertible level at about the level quoted in the NYT then Iceland will not go through the extent of crisis I originally thought.  And if it is freely convertible whoever purchased Krona at 350 to the Euro on the day of the crisis made a fabulous trade.  Find that trader!

 

 

John Hempton

PS - Some follow up.

I found a good end-of-October internet post about the situation.  The rationing of foreign currency is indeed severe and the exchange rates are hence meaningless.  I would love to know the extent of the rationing and whether a black market has developed in the currency.   If people wish to add to or correct material here I would appreciate it.

Anyway here is the post material:

 Iceland situation

---

I've not written anything about the situation in Iceland for just over a week now. Here is the latest from my perspective as an Icelander.


- The Central Bank lowered interest rates last week from 15,5% to 12%. However, because of agreement with the IMF before the weekend, interest rates were raised to 18% today.
This means companies and individuals, that are already struggling to pay loans, will suffer even more. No new loans at all from anywhere.

- The IMF agreement last week gives us $2.1 billion to prop up our currency. This is not enough, and we're seeking an extra $4 billion from other countries, the Fed, ECB and Scandinavian CB's.

- It is estimated that economic contraction will be around 10%.

- It is estimated that 20% of companies will not be able to pay payroll this month. I have a feeling a lot of companies are just "ghost" companies, people still working, but the company is essentially bankrupt.

- Massive layoffs in the construction industry, and the banking sector of course.

- Inflation roared to 15,5% this month, expected to rise.

- Our currency is still worthless and still not traded overseas. Although there was a news today that hinted there was some trade with the ISK, where it was less than half the value that our CB claims.

- I must note that there are no shortages (yet) of food, fuel and medicine, or much else I've noticed. But if current situation continues then we could see some shortages, but not of necessities. However, because of rationing of foreign currency other importers are not able to import new supply of e.g. clothes, industry material etc. I expect many companies not being able to continue their operations because of import restrictions.

- The sovereign state has not yet defaulted on any loans, despite statements in the foreign media. It requires a lot of help to get back on it's feet, and seems to be getting it soon.

- A lot of families are "stuck" in their homes, cannot sell, cannot move, cannot buy. The mortgage debt is around 10-40% higher then the value of their homes. Home value is expected to drop significantly in the coming months.

- The government owns all the banks, and indirectly owns all the media, and all the debt of the people. With taxes and debt payment the people are in a state of servitude to the government. Not many realize this.

- Some conspiracy theories are on the icelandic forums that the government is censoring the media, directing them to mitigate the news. They own all the media after all!

- Many are considering strategies out of this, e.g. husband and wife divorcing and allowing one of them to default on the debt and go bankrupt, while the other one keeps a clean slate. Some are thinking about fleeing to another country.

- The government has been able to offer a temporary freeze on payments on mortgages, 4-6 months. The depression is expected to last at least 1 year, maybe 2 years.

- There are some protests, but they seem to be minor. There is general calm, but still anxiety, frustration, over the situation. I expect things to get a lot worse when people lose their jobs and have nothing better to do than to protest.


I think the coming friday/monday is the big reveal moment, e.g. who pays the payroll and who doesn't. Just then we'll realize how serious the situation is. I expect thousands to lose their jobs.


How does once a free-market capitalist system, with the highest standard of living in the world, the most freedom of the press in the world, the happiest people in the world and least corrupt people in the world turn into a Orwellian fantasy almost overnight is beyond me.

Global diversification – an Australian perspective

There is a post by Dennis P. Quinn   Hans-Joachim Voth – good Finance professors both of them – on why international diversification does not seem to deliver the benefits that were expected.  They argue that globalisation has made everything more correlated. 

I think they are spectacularly wrong.

Obviously the good Professors are not Icelandic.  Iceland really has almost totally melted down – and if you were Icelandic but have global assets you have done just fine thank you very much.  In Kroner you might be up 500 percent even if your foreign assets were not that good.  Having an even small percentage of your wealth diversified globally has saved your sorry and cold Icelandic backside…

I enjoy all those mathematical models that suggest that if it is correlated it is not diversified.  But day-to-day correlation is not where it is at.  What you really want is “uncorrelated in a crisis”.  International diversification is pretty good at that.  Iceland has had a crisis – but New Zealand for instance – a country often paired with Iceland looks OK for now.

Now I am going to give you an Australian perspective.  Felix Salmon points us to a Merrill Lynch report that suggests on measures like current account deficit, short term funding requirements etc (all the things that obsess me) that Australia is the riskiest country in the world.  Latvia obviously is not a country according to Merrill Lynch – but they are more or less right.  Australia really is risky.  It has an American style spending habit, a property boom that allows me to go to Sausalito and think the houses are inexpensive (they are compared to Bronte).  And it has an economy highly dependent on a small number of commodity exports.  (Iron ore and China looks like a risk to me.) 

In other words Australia could do an Iceland.  I don’t think it will – Australia has a few advantages which include a government that has fiscal credibility and very low debt levels, a banking system that is relatively small to GDP (at least compared to Iceland), and the minerals that China needs (and will need more of one day). 

But Australia is not riskless.  The risks whilst small are very real.  And if you are a well-to-do Australian and you are not diversified at least 20 percent globally you are doing yourself no favours.  Those with self-managed superannuation funds should pay heed.

If you are an Australian and you diversify globally but swap the currency back to Australian dollars (as one well known retail fund manager does) you are also failing to diversify.  The main advantage of diversification internationally is that it removes the country specific catastrophe risk and swapping the currency back is simply insane.  Indeed an Australian retail international fund that wants to swap all the currency back is putting marketing ahead of client asset protection and is – in my view – almost criminally negligent.  Just think how an Icelandic international fund would look if it had swapped its currency exposure back to Kroner!  They would be a wipe-out because they would have to sell their valuable international assets to meet their obligations to deliver valuable foreign currency for worthless Kroner. 

But what is good for an Icelandic person or an Australian (some global diversification fully accepting currency risk) is good for an American too.  The US is bigger and more stable than Iceland or even Australia – but it is not riskless.  There remains a small chance that somehow the US will become a fascist dictatorship.  The chance I suspect is smaller after last Tuesday – and might be vanishingly small anyway – but it is not zero.  There are plenty of things that can go wrong. 

And there is a small chance that the US could go to pot in ways that I can’t envisage.  And in that case international positions would not be entirely correlated.  The US might take some of Europe down with it – but China and Australia might be OK.  A little international diversification would be great for Americans too.

The dear Professors have this wrong.  International stocks are correlated but not entirely and not in extrema.  Rich people in small Latin American countries know this.  Maybe the good Professors should too.

 

 

John Hempton

AIG - thy name is opaque

I have been thinking about playing in the common securities  of AIG.  My view is that an awful lot of CDOs (and their CDS) are trading at levels way below where they will eventually settle.  [Illiquid markets and inability to borrow etc.]

In that case AIG common may be a good bet - because the collateral posted for future losses will be in part returned.

Then along comes this story (hat-tip to Felix) that AIG is lobbying hard to get the interest payments on the government loan reduced.  This suggests further liquidity problems.

I think I will leave that one in the "too hard basket" at least for a while.

John

The Wisconsin Insurance Commissioner lets Ambac have its 3 billion

Thanks to "anonymous" pointing it out in the comments.  Here is the release from the commissioner...

http://www.oci.wi.gov/pressrel/1108ambac.htm

I suspect Ambac is - again - a reasonable speculative bet.

Am I going back?  Need to think about it for a few days...

J

Berkshire Credit Default Swaps

I am quite familiar with Berkshire - about as familiar as you can get by reading stat statements and the like.

I can not blow it up.  That means I know of no reason whatsoever that it could wind up insolvent in five years.  

That does not mean it can not happen.  If 9.11 had been nuclear they might have had problems - but as my "Risk Aversion Berkshire Style" post makes clear fat tail risk is not part of the formula.  

So why is the five year credit default swap spread on Berkshire over 200bps?  I have no idea and it makes no sense to me.  

Maybe it is just irrational bearishness about everthing (ie BUY HARD) or maybe there is something I do not know.

So if anyone wants to post/reply a case for Berkshire CDS please...

John Hempton

Ambac: A surprisingly liquid after-market

Ambac looks like toast.  The downgrade gives them a massive and immediate liquidity call - and whilst I believe the insurance company will be ultimately solvent I express no such thing about the parent company.

I believe it is in the interests of the insurance commissioner to let money out of the insurance company to bail out the holding company.  But I have no assurance that the commissioner would do such a thing.

I sold - the last of my holding in the after-market.

The after-market was VERY liquid.  Surprisingly so.  So much so I am wondering whether someone knew more than me...

I guess I find out tonight my time.

John Hempton

My number 2 blowup

Moodys has cut Ambac's rating to a level that triggers the GIGs to pay and hence causes a liquidity event.

The liquidity event can be prevented by the insurance commissioner who might yet come to the party (and I think should in the interest of his policy holders).  But if the insurance commission does not come to the party Ambac will file bankruptcy.

http://biz.yahoo.com/ap/081105/ambac_moody_s_downgrade.html?.v=1

J

Walmart: Where is a statistician when you need one?

Extracted from the shareholder letter of the last Walmart annual report:

Improving Customer Experience

We continue to invest in improving the customer experience in our stores - faster checkouts, friendlier service and cleaner premises. Our customers are taking  note.  We survey almost two million customers every quarter, and they 

are validating the improvements.

I couldn't fathom this.  Surveying nearly 8 million people per year means that Walmart has a better handle on what the population wants that just about anyone.  

But somewhere I learnt the central limit theorem and the law of large numbers suggests that you don't obviously need to survey that many people unless you are dealing with very fine nuances...  

So please dear readers - what is Walmart doing here?  And why does it give them a competitive advantage?

John Hempton

PS.  If Walmart were a political party surveying that many people I would think were push polling.  It is not that - so what is it?

It is surprising how few people got the joke...

The hedge fund trade was long Porsche, short Volkswagen.  

Porsche after all owns many times its market cap in VW shares so the trade was obvious...

This has been a disastrous trade.  Plenty of hedge funds got hurt bad.  Most of them are still long Porsche.

When I suggested the only responsible trade was short Porshe I was teasing.  A serious tease because Porshe is playing with fire and there are ways that Porsche could go bust.  But it is not a position I would put on.  

Calling it "the only responsible trade" was a tease.  Pure and simple...

Sorry if it did not translate to print.

John Hempton

The only responsible trade...

Warning – I strongly recommend against trading in any security mentioned in this post. The volatility is enormous and the situation fluid. The stocks are not being driven by fundamentals… The recommendations in this post are made in a somewhat humorous manner. They might even be reckless...

I am horrified - despite this warning at least one person has thought that the trade should be placed. Please take this warning seriously. I have no position.

The Stutz Motor Car Company

There was once a fine American sports car company called Stutz. It made beautiful – even legendary cars. The cars had a reputation for dependability, reliability and punishing speed. I know they look antique – but these were really quick for their day – and they won big races like Indianapolis and the Le Mans 24 hour race. Le Mans (at least) is an event that Porsche likes to win. Here is their 1913 Stutz Bearcat – a car that was modified, overpowered etc and won races into the mid 1920s.

Anyway Stutz was controlled by Alan Aloysius Ryan through family holdings. For reasons mostly to do with improved mass production by competitors the company found itself under pressure. Short sellers could smell blood. And they shorted the stock. And shorted some more.

Through this Alan Aloysius Ryan stood firm, buying stock when he could (possibly through options and hidden holding companies so the shorts could not see what he had done). He did this until he declared one day in 1920 that he owned 105 percent of the company and the shorts could settle with him on his terms.

His terms were a price so high that it would bankrupt broker dealers who had stood as intermediaries between the stock exchange and shorts.

Well to put it bluntly the financial market and regulators defended their own. The story is told here and here and here and here in the New York Times – and the amounts of money involved were monstrous for the time. Eventually the New York Stock Exchange –with the threat of criminal proceedings – arbitrarily determined a price to settle the short positions. The shorts even got an officially sanctioned “protective committee”.

That price was way below the top price that Ryan paid – but far more than intrinsic value. The shorts – well – except those that shorted right at the end – lost money. Ryan wound up paying too much for a motor car company which was slowly declining anyway. As he now owned 100 percent of Stutz his debts got intertwined with the car company and both he and the car company went bust. Some family members got a little out but only by suing other family members. The only winners were ordinary longs of Stutz who sold along the way – or even at the final settlement price.

As you might have guessed this looks horribly familiar. Porsche is now firmly in control of Volkswagen – and they did it with non-standard cash settled options and other things they argue that they did not need to disclose. It looks and smells like market manipulation – and Volkswagen – General Motors for Europe – may be - depending on the time of day - the biggest company in the world by market cap. [Yes – its market cap is higher than Microsoft, Exxon or PetroChina.] This is the short-squeeze from hell – the first short-squeeze to infinity since the Stutz corner…

Now I think Porsche is one of the great businesses of the world. They have convinced middle aged richer Americans that they are more attractive – or at least more fun – if they drive that particular fast car. (Viagra is for poorer guys…)

And unlike Ferrari (which spends all of its profits on Formula One) Porsche – like Stutz before it – managed to make its mark with near-production cars in events like Le Mans. In the automobile world there are only two car companies with margins near 10 percent – Porsche and Toyota. And they got there different ways.

Porsche (the business) is having a rough time at the moment because if you haven’t noticed the willingness of middle aged American men to drop 100K on a car is somewhat reduced of late. But that might be temporary.

Porsche is a company I want to love – a very fine consumer brands company masquerading as an automobile company. And it is not expensive at the moment – especially if you back out their holding of Volkswagen. Indeed its holding of Volkswagen is worth many times Porsche’s market cap – making Porsche one of the cheapest stocks in the world.

But if history is a guide the Porsche and its controlling family are going to go the way of the Ryans. Their behaviour doesn’t look any more criminal than Alan Aloysius Ryan – and that wound up with him – and his company bankrupt. The system has a knack of defending itself – and the family that controls Porsche and indeed the Porsche company itself is every bit as expendable as Alan A Ryan.

I started this post with a warning – which was that nobody should play any security involved in this story – and I want to stick with this warning. But if you want to play – and it pains me to say this – the only responsible trade is to short Porsche. Porsche – the company – and possibly the car – like Stutz before it – will likely get confined to the dustbin of history.

This is a sad thing – because Porsche – as I have noted – is a nicely run and profitable company. But the appearance of criminal market manipulation will have consequences – and Porsche will pay the piper. My guess – some hapless European investment bank (say Fortis or UBS) is at risk in this – the greatest squeeze since Stutz – and the European court when forced to decide between a mid-ranking German car company and a bank that is integrated with a European government they will chose the bank at Porsche’s expense.

Porsche lovers can however console themselves if they are going to live another 40 years. Someone made some pug-ugly cars under the name of the “New Stutz Company” in the 1960s. Elvis Presley loved his. A small consolation – but the name lives on well after any family legacy is gone.

John Hempton

PS. Having spent some time the other day slamming the New York Times I would thank them for making available – for free no less – the original newspaper articles about the Stutz Corner.